finman - ch10
TRANSCRIPT
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 1/27
C h a p t e r
C h a p t e r
Valuation and Ratesof Return
Valuation and Ratesof Return
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 2/27
Chapter 10 - Outline
Valuation Concepts
Valuation of Bonds3 Factors that Influence
the Required Rate of ReturnRelationship Between Bond Prices and Yields
Preferred StockValuation of Common Stock
Valuation Using the Price-Earnings Ratio
Summary and Conclusions
PPT 10-2
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 3/27
PPT 10-3Figure 10-1 / The relationship betweentime value of money, required return, cost
of financing, and investment decisions
Presentvalue
concepts
Required rates of return by investors
Valuation
Analysis of projects based
on cost of financingto the firm
Cost of financing
to the firm
Chapter 10
Chapter 9 Chapter 11 Chapters 12 and 13
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 4/27
Valuation Concepts
The value or price of a stock or bond is based upon
the present value of future expected cash flows tothe investor
The discount rate used is investors’ required rate of
return, based on the market’s estimates of risk,
efficiency, and expected future returns
PPT 10-4
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 5/27
Valuation of Bonds
The value of a bond is made up of 2 parts:
PV of the interest payments (an annuity)
PV of the principal payment (a lump sum)
The principal payment at maturity: can also be called the par value or face value
is usually $1,000
The interest rate used:
is the yield to maturity or discount rate is also the required rate of return
PPT 10-5
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 6/27
The present value (price) of a bond
return)of rate(requiredmaturitytoyieldthe Y
periodsof numbertotalthen
nto1fromperiodthet
maturityatpaymentprincipalthePn
paymentsinterestperiodictheItbondtheof pricemarketthe Pb
:where
)1()1(1
=
=
=
=
==
+++= ∑=n
nn
t t
t
bY
P
Y
I
P
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 7/27
Relationship BetweenBond Prices and Yields
Bond prices are inversely related to bond yields (move
in opposite directions)
As interest rates in the economy change, the price or
value of a bond changes: if the required rate of return increases, the price of
the bond will decrease
if the required rate of return decreases, the price of
the bond will increase
PPT 10-8
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 8/27
Bond price and required rate of
return(yield to maturity) If the market rate is higher than the coupon rate
(the annual interest payment divided by the parvalue), the bond will sell at discount (below par
value)
If the market rate is equal to the coupon rate, the
bond will sell at par value
If the market rate is lower than the coupon rate, thebond will sell at premium ( above par value)
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 9/27
Table 10-1
Bond price table
(10 Percent Interest Payment, 20 Years to Maturity)
Yield to Maturity Bond Price
246
789
10
11121314162025
% . . . . . . . . . . . . . . . . . . . . . . $2,308.11. . . . . . . . . . . . . . . . . . . . . . . . 1,815.42. . . . . . . . . . . . . . . . . . . . . . . . 1,458.80
. . . . . . . . . . . . . . . . . . . . . . . . 1,317.82. . . . . . . . . . . . . . . . . . . . . . . . 1,196.36
. . . . . . . . . . . . . . . . . . . . . . . . 1,091.29
. . . . . . . . . . . . . . . . . . . . . . . . 1,000.00
. . . . . . . . . . . . . . . . . . . . . . . . 920.37. . . . . . . . . . . . . . . . . . . . . . . . 850.61
. . . . . . . . . . . . . . . . . . . . . . . . 789.26
. . . . . . . . . . . . . . . . . . . . . . . . 735.07
. . . . . . . . . . . . . . . . . . . . . . . . 644.27
. . . . . . . . . . . . . . . . . . . . . . . . 513.04
. . . . . . . . . . . . . . . . . . . . . . . . 406.92
PPT 10-7
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 10/27
3 Factors that Influence theRequired Rate of Return
Real Rate of Return:
represents the opportunity cost of the investment
in the early 1990’s, 5-7%, but now about 3-4%
Inflation Premium:
a premium to compensate for the effects of inflation lately, 2%
Risk Premium:
a premium associated with business and financial risk
typically, 2-6%
So, the Required Rate of Return equals:
Real Rate of Return + Inflation Premium + Risk Premium
PPT 10-6
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 11/27
Bond price, required rate of return, time to
maturityBond prices are inversely related to required rate of
return. A change in the required rate of return willcause a change in the bond price in the opposite
direction
The impact of the change in required rate of return
on the bond price is depend upon the remainingtime to maturity. The impact will be greater the
longer the time to maturity.
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 12/27
0 . . . . . . . . $1,000.00 $1,000.00
1 . . . . . . . . 1,018.52 982.14
5 . . . . . . . . 1,079.85 927.90
10 . . . . . . . . 1,134.20 887.00
15 . . . . . . . . 1,171.19 863.78
20 . . . . . . . . 1,196.36 850.6125 . . . . . . . . 1,213.50 843.14
30 . . . . . . . . 1,225.16 838.90
Time Period Bond Price with Bond Price with
in Years 8 Percent Yield 12 Percent Yield(of 10 percent bond) to Maturity to Maturity
PPT 10-9
Table 10-2
Impact of time to maturity on bond prices
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 13/27
1,300
1,200
1,100
1,000
900
800
700
Bond Price ($)
30 25 15Number of years to maturity
10% bond, $1,000 par value
Assumes 12% yield to maturity
* The relationship in the graph is not symmetrical in nature.
5 0
Assumes 8% yield to maturity
PPT 10-10Figure 10-2
Relationship between time to maturity and
bond price*
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 14/27
Your Daily PaperIssuer Coupon Maturity Price Yield Change
BC Tel 9.65 Apr 8-22 138.5 6.488 +1.118
CompanyCompany NameNameCouponCoupon
(interest rate %)(interest rate %)
Maturity DateMaturity Date(April 8, 2022)(April 8, 2022)
PricePrice
(Last transaction(Last transactionprice = $138.50/ $100price = $138.50/ $100
of face value)of face value)
Yield Yield(( Annual interest Annual interest
Market price)Market price)
ChangeChange
(Closing(Closingprice up $1.12/price up $1.12/
$100 from$100 from
previous day)previous day)
PPT 10-11
Reading Bond Quotations
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 15/27
Compute the yield to maturity
Trial and error process
Interpolation methodA less exact calculation of the yield to maturity
Principal -Price of the bond
Approximate Yield=
Annual interest payment + Number of years to maturity
to Maturity . 6 (Price of the bond) +.4( Principal payment)
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 16/27
Valuation of Preferred Stock
Preferred stock:
usually represents a perpetuity (something with nomaturity date)
has a fixed dividend payment
is valued without any principal payment since it hasno ending life
is considered a hybrid security
owners have a higher priority of claim than commonshareholders
price is based upon PV of future dividends
PPT 10-12
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 17/27
Valuation of Preferred Stock
p
p
p p
p
p
p
p
p
p
K
D
K
D
K
D
K
D
K
DP
=
++⋅⋅⋅⋅+
++
++
+=
∞
∞
)1()1()1()1( 321
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 18/27
Valuation of Common Stock
The value of common stock is the present value of a
stream of future dividends
Common stock dividends can vary, unlike preferred
stock dividends
There are 3 possible cases: No growth in dividends (valued like preferred stock)
Constant growth in dividends
Variable growth in dividends
Required rate of return reflects the dividend yield
on the stock and the expected growth rate in thedividend
PPT 10-13
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 19/27
Valuation of Common Stock
General formula
No growth in dividends
Constant growth in dividends
eK
DP 0
0 =
gK
DP
e −= 1
0
∑∑∞
==
∞
∞
+=
++
+=
++⋅⋅⋅⋅+
++
++
+=
11
3
3
2
2
1
1
0
)1()1()1(
)1()1()1()1(
t t
e
t
n
e
nn
t t
e
t
eeee
K
D
K
P
K
D
K
D
K
D
K
D
K
D
P
PPT 10 14
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 20/27
Valuation Using the Price-Earnings RatioPPT 10-14
The Price-Earnings (P/E) ratio can also be used tovalue common stocks
The P/E ratio is influenced by many factors:
the earnings and sales growth of the firm
the risk (or volatility in performance)the debt-equity structure
the dividend policy
the quality of management
a number of other factors The average P/E ratio for TSX Composite, excluding Nortel and JDS
Uniphase, in early 2002 was 33 to 1
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 21/27
High vs. Low P/Es
PPT 10-15
A stock with a high P/E ratio:
indicates positive expectations for the future of thecompany
means the stock is more expensive relative to earnings
typically represents a successful and fast-growingcompany
is called a growth stock
A stock with a low P/E ratio: indicates negative expectations for the future of the
company
may suggest that the stock is a better value or buy
is called a value stock
T bl 10 4 PPT 10 16
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 22/27
Table 10-4
An example of stock quotations from the
Globe and Mail
PPT 10-16
Source: ILX Systems, a division of Thomson Information Services Inc.
PPT 10-17
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 23/27
Your Daily PaperCompany Volume High Low Close Change
Inco 3760 29.150 28.500 28.600 -.400
Stock Stock
Volume Volume(Total number of(Total number of
shares traded (100s)shares traded (100s)
CloseClose(Last price paid(Last price paid
at close of trading)at close of trading)
HighHigh
(Highest(Highestprice paidprice paid
per share forper share for
the daythe day was $29.15) was $29.15)
LowLow(Lowest price paid(Lowest price paid
per share for the dayper share for the day
was $28.50) was $28.50)
ChangeChange(Difference between(Difference betweentodaytoday’’s price ands price and
previous dayprevious day’’s. A s. A
.40 decrease).40 decrease)
PPT 10-17
Reading Stock Quotations
PPT 10-18
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 24/27
Valuation of a Supernormal Growth Firm
0 8
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 25/27
Stock valuation under supernormal growth
n
ece
n
sn
t t
e
t
s
K gK
g D
K
g DP
)1)((
)1(
)1(
)1( 0
1
00
+−
++
+
+=∑
=
PPT 10-19Figure 10B-1
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 26/27
PPT 10 19Figure 10B-1
Stock valuation under supernormal growth
analysis
PPT 10-20
8/3/2019 FinMan - Ch10
http://slidepdf.com/reader/full/finman-ch10 27/27
Summary and Conclusions
The price of a bond reflects thepresent value of future payments of
interest and principal, discounted at
current market bond yields
The price of a preferred orcommon stock reflects the present
value of future dividends,
discounted at current market
dividend yields
An alternative for valuing
common stock is the price-earnings
ratio
The value of securities is based uponthe present value of expected future
cash flows from the investment,discounted at the rate of returnrequired by investors
The required rate of return includes
premiums for expected inflation andthe perceived risk of the investment